It's Time to Uproot the Real Cause of the Mortgage Crisis

As banks, insurance companies, brokerage firms, automobile manufacturers, and God knows who else line up to try and feed at the public trough, the original source of the spreading financial and credit crisis, the mortgage industry, is still in deep trouble. Whether the initial bailout plan passed by Congress will help stem mortgage lenders’ financial problems in the short run is still an open question. But one thing is certain: Nothing in the original legislation or Treasury’s actions and infusion of funds since then have made the legal, regulatory, and enforcement changes required to prevent this problem from happening again in the long run -- no matter how many tax dollars the Treasury Department pours into the problem.

Nothing in the mortgage bailout legislation called for Congress to fix the serious problems with the Community Reinvestment Act (CRA) that empower ACORN-style pressure tactics against lenders. Nothing made the Federal Reserve change its lending instructions. Nothing urged the president to change the enforcement policies at the Justice Department and HUD that forced lenders to make risky loans to unqualified applicants.

At its most basic level, this crisis started because of the weakening of mortgage lending standards caused by the Federal Reserve and other federal agencies. Lenders also feared facing discrimination claims and enforcement actions by government law enforcement agencies and organizations such as ACORN.

Consider a faulty study the Boston Fed conducted in the 1990s. It claimed that minority mortgage applicants were rejected at higher rates because of discrimination. Yet a detailed analysis by University of Texas economists Stan Liebowitz and Theodore Day showed that the Boston Fed study was so full of data transcription errors that it was “outrageously unreliable.” When those errors were eliminated, there was no discrimination. Some minority groups do have a higher rejection rate for mortgages on average, but because of weaker credit histories, not discrimination by lenders.

Undaunted, the Boston Fed issued a new manual that called traditional lending standards like creditworthiness and down payment requirements “outdated” and “discriminatory” because they supposedly prevented minorities from getting loans. Other federal agencies joined in. The FDIC still has a compliance manual that discourages banks from requiring an “excellent” credit rating or “adequate” longevity on the job because it may have a “disparate impact” on minority applicants. This despite the current crisis and the fact that in 2007 the Federal Reserve finally admitted in a report to Congress that credit scores are “predictive of credit risk for the populations as a whole and for all major demographic groups.”